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ADP: Is it a good choice for long-term investors?


In an era where technology and human resource management intersect, Automatic Data Processing, Inc. (ADP) stands out as a key player. Renowned for its comprehensive payroll services and human capital management solutions, ADP's unparalleled experience, expertise, insights, and cutting-edge technology have transformed human capital management from an administrative challenge to a strategic business advantage. Therefore, the runway should be long for ADP. The question is whether now is the right time to invest?


This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.


Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.


For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of ADP. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in ADP's competitors either. Thus, I have no personal stake in ADP. If you want to purchase shares or fractional shares of ADP, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.



Automatic Data Processing, Inc. (ADP) was founded in 1949 in New Jersey, United States. The idea was to assist clients in focusing on their business by addressing their payroll challenges. ADP is now one of the world's leading global technology companies, offering comprehensive cloud-based human capital management (HCM) solutions that integrate HR, payroll, talent, time, tax, and benefits administration. ADP serves over 1 million clients and pays over 41 million workers in 140 countries and territories. ADP has two reportable segments: Employer Services and Professional Employer Organization. Employer Services caters to clients of all sizes, from small businesses with a single employee to large enterprises with tens of thousands of employees worldwide. ADP offers a range of solutions, including Payroll Services, Benefits Administration, Talent Management, HR Management, Workforce Management, Compliance Services, Insurance Services, and Retirement Services. Professional Employer Organization (PEO) offers clients comprehensive outsourcing solutions for employment administration. This involves a co-employment relationship where employees working for a client (referred to as "worksite employees") are co-employed by ADP and the client. ADP assumes certain employer responsibilities, such as payroll processing and tax filings, while the client retains control of its business and all management responsibilities. Professional Employer Organization (PEO) is particularly beneficial for small and mid-sized businesses that may not have in-house HR expertise. Employer Services contribute 67% of the revenue, while Professional Employer Organization contributes 33%. ADP generates most of its revenue from subscription fees, which means the company's business is typically defined by long-term client relationships that lead to recurring revenue. ADP is one of the most well-known and respected names in the HR and payroll services industry, which means they have a strong brand moat.


Their CEO is Maria Black. She joined ADP in 1996 as a sales associate and held various positions until she became ADP's seventh CEO in January 2023. She holds a Bachelor of Arts degree in Political Science and International Affairs from the University of Colorado, Boulder. Maria Black was appointed as CEO due to her demonstrated strength in leadership development over two decades. The board is confident in her ability to continue building on ADP's strong foundation and ensuring its success in the future. Furthermore, Maria Black's experience in various positions at ADP has provided her with a comprehensive understanding of the business, from the ground up. This has equipped her with a powerful perspective on ADP's products, innovation strategy, and growth opportunities. As a CEO, she has introduced three key strategic priorities: leading with best-in-class HCM technology, providing unmatched expertise and outsourcing to their clients, and leveraging ADP's global scale for the benefit of their clients. If she succeeds, these key strategic priorities will enhance ADP's competitive advantage. Maria Black is also well-liked by employees, as evidenced by her employee score of 89/100 at Comparably, which places her in the top 5% of similar-sized companies. Nonetheless, it is impossible to determine whether Maria Black is a good CEO with so little time in charge. However, I will give her the benefit of the doubt due to her extensive experience in the company, and because I believe the key strategic priorities will enhance ADP's competitive advantage.


I believe that the ADP has a strong brand moat, and I have confidence in the management despite their recent appointment. Now, let's analyze the numbers to determine if ADP meets our criteria for having a strong competitive advantage. If you need an explanation of what the numbers represent, you can refer to "MY STRATEGY" on the website.


The first metric we will investigate is the return on invested capital (ROIC). I would like a 10-year history demonstrating a minimum growth of 10% each year. ADP has consistently achieved a high Return on Invested Capital (ROIC) of over 20% for the past ten years, and over 30% for the past five years. Another positive aspect is that ADP has achieved its highest Return on Invested Capital (ROIC) in the past two years, delivering impressive numbers that have continued to grow year over year. These numbers are very impressive, and it's not often that you find companies that manage to deliver such results.



The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are used to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The numbers are a bit mixed, which can partly be explained by acquisitions. For example, ADP has acquired companies such as The Marcus Buckingham Company, Global Cash Card, WorkMarket, Celergo, and Sora over the past 10 years. Therefore, I am not concerned about the changes in equity and years of decline.



Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising to note that ADP has consistently generated positive free cash flow every year for the past decade. It is also encouraging to see that ADP has increased its free cash flow in almost every year compared to the previous year. The levered free cash flow margin has consistently been high, and it is encouraging to note that the levered free cash flow margin reached its highest level in the past decade in fiscal year 2023. The free cash flow margin suggests that the company is not currently overpriced, but we will revisit this later in the analysis.



Another important aspect to consider is the amount of debt. It is crucial to determine if a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After analyzing the financials of ADP, I found that the company has 0,88 years of earnings in debt. Therefore, debt is certainly not a concern for ADP.



Based on my findings so far, I find ADP to be an intriguing company. However, no investment is without risk, and ADP also has its fair share of risks. One risk is competition. In its annual report, ADP mentions that the industries in which they operate are highly competitive. There are numerous companies that offer similar services. This competition could impact ADP's market share and pricing power, particularly if competitors introduce more innovative or cost-effective solutions. Some of ADP's competitors are well-known companies, such as Paychex, Workday, Intuit, Oracle, and SAP. ADP is also exposed to technology and cybersecurity risks. In its annual report, ADP mentions that the nature of their business involves collecting, hosting, storing, transferring, processing, disclosing, using, securing, retaining, and disposing of personal and business information. They also collect, hold, and transmit client funds. A security or privacy breach may damage or disrupt their business, result in the disclosure of confidential information, damage their reputation, increase their costs, cause losses, and materially adversely affect their results of operations. Regulatory and compliance risks. ADP operates in a highly regulated industry, which means that their business is subject to a wide range of complex U.S. and foreign laws and regulations. Changes in employment laws, tax codes, or other regulations can affect ADP's operations. Failure to comply with these laws and regulations could cause ADP to incur substantial costs or result in the suspension or revocation of licenses or registrations, the limitation, suspension, or termination of services, the imposition of consent orders, civil and criminal penalties, including fines, and lawsuits, including class actions, that could damage their reputation and have a materially adverse effect on their results of operation or financial condition.


There are also numerous reasons to invest in ADP. One reason is that they operate in an appealing industry. ADP believes that their current total addressable market, which includes payroll, workforce management, HR, benefits, talent, HR outsourcing, analytics, and payments, is worth $150 billion. ADP's revenue is currently around $18 billion, indicating significant potential for growth. Furthermore, the market is expected to grow at a 5-6% compound annual growth rate (CAGR) in the future, further increasing the size of the total addressable market. International growth. ADP currently generates 12,7% of its revenue from outside the United States. CEO Maria Black has expressed her enthusiasm for the long-term growth potential in their international operations, emphasizing that they view the international market as a continued opportunity for ADP. She mentioned that she sees growth opportunities across the board in international markets. Under her leadership, ADP has successfully expanded its chat-based mobile payroll solution, Roll by ADP, into the Irish market, marking the beginning of its expansion into the European market. ADP has also acquired the payroll business of Swedish BTR, which provides ADP with a physical presence in Sweden. Management has expressed their intention to further expand into the Nordic region to capitalize on the growth potential of those economies. Shareholder-friendly. ADP is a shareholder-friendly company because it consistently returns cash to its shareholders. ADP has achieved 48 years of consecutive dividend increases, positioning the company to soon become a "dividend king." ADP has a target dividend payout ratio of 55-60%. Furthermore, ADP is also repurchasing shares as part of its long-standing share repurchase program, which has resulted in an average annual decline of 1% in share count over the last 10 years.



Now it is time to calculate the share price of ADP. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 7,52, which is from the fiscal year 2023. I have selected a projected future EPS growth rate of 12%. Management expects EPS to grow between 11-13%. Additionally, I have selected a projected future P/E ratio of 24, which is twice the growth rate. This decision is based on ADP's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $138,56 We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy ADP at a price of $69,28 (or lower, obviously) if we use the Margin of Safety price.


The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 4.208, and capital expenditures were 572. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 400 in our calculations. The tax provision was 1.028. We have 411,7 outstanding shares. Hence, the calculation will be as follows: (4.208 – 400 + 1.028) / 411,7 x 10 = $117,46 in Ten Cap price.


The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With ADP's free cash flow per share at $8,88 and a growth rate of 12%, if you want to recoup your investment in 8 years, the Payback Time price is $122,33.


I find ADP to be an intriguing company. ADP has new management, but the new CEO, Maria Black, has been with the company for more than two decades. This makes me comfortable with her leading ADP moving forward. ADP is facing interconnected risks. Currently, ADP holds a strong market position due to its reputation, which is why I'm not concerned about competition. However, technology, cybersecurity, and regulatory and compliance risks will always be factors of risk for ADP. There is currently no indication that ADP will experience any security or privacy breaches or fail to comply with laws and regulations. However, if such an event were to occur in the future, it could potentially impact their business and diminish their competitive advantages. Therefore, it is something that needs to be monitored when investing in ADP. I appreciate that ADP is shareholder-friendly and has ample room for growth. Furthermore, ADP has achieved exceptional historical performance, demonstrating the strength of their business. I would love to add ADP to the portfolio if it drops to $200, as this would provide me with a nearly 20% discount to the intrinsic value of the Payback Time price.


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